 You
are familiar with retirement, right? Is the idea of retirement ever
occurs to you? Or, is there some point in your life when you realized
that someday you will need to leave the work force for a certain
purpose? If so, it's the time for you to learn about IRA.
So what is IRA? What does the term "IRA" stand
for? What are involved in it? What are Traditional IRA and Roth IRA?
How do these terms differ and what are their benefits and drawbacks?
What is IRA?
IRA is basically not a new concept. The reality
is it has been around for about 30 years now. It first came out in the
public when it was introduced with the 1974 Employee Retirement Income
Security Act, commonly known as ERISA.
IRA originally stands for Individual Retirement
Arrangement and was originally designed as a tax-sheltered plan to help
people who have no company pension in supporting their requirements.
However, as time passed by, some changes were made to the plan. The
term IRA now stands for Individual Retirement Account and has been
considered as a kind of retirement investing tool designed for the
people working on public and private companies and their non-working
spouses. It has been noted for a nice kind of chance it provides to
those who wish to earn bucks even after retirement. Yes, IRA in fact
offers the chance to get money through annual contributions in which up
to the maximum amount set by the company is allowed.
Speaking of contributions, the IRA is essentially
a retirement plan that allows you to contribute a portion of your
earned income every year. It has been maintained that if you are 50
years of age or older, you have the right to contribute even more to
your IRA. However, the contributions must be equal to the amount of the
contribution limits set, and these limits change year after year.
For example, the annual contribution limits that individual may consider for IRAs include the following:
- Tax years 2006 to 2007 - About $4,000 for those who are under the age of 50, and $5,000 for those who are 50 and above.
- Tax year 2008 - $5,000 for those under 50 and $6,000 for those 50 and above.
Based on these limits, married couples have the
right to contribute to an IRA even if only one had an earned income for
the year provided that the working spouse earns sufficient income to
cover the IRA contributions for both.
It is further worth noting that the contributions
limit for IRA is now increasing and there are particular requirements
set for the applicants to meet. The requirements, however, depends on
the company and how the plan is set up. It is also due to this
difference that IRA now stands for Individual Retirement Accounts when
it is set up with the financial institutions, and it would be called
Individual Retirement Annuity when it was set up with a life insurance
company through annuity.
Types of IRA: Traditional IRA and Roth IRA
IRA comes in a number of types. There are the
Traditional, Roth, Spousal, Rollover, and the ones designed for
children and education. Of these types, two stand out as popular: the
traditional IRA and the Roth IRA.
Let's take a closer look on these popular types of IRA one by one.
Traditional IRA
A Traditional IRA is in the first place a type of
individual savings plan. The contributions are made up to a particular
limit specified by the company with the contribution tax deductible.
However, it allows earnings and deductible contributions to grow
tax-deferred. In this case, the money invested and earned in your
traditional IRA are subject only to income taxes at the time of
withdrawal. To put it simple terms, you don't need to pay income taxes
on the earnings as well as the deductible contributions of your IRA
until you start taking withdrawals, which generally happens after you
leave from the work force or when you find yourself in the lower tax
bracket.
For more emphasis on withdrawals, it is
maintained by certain traditional IRA rules that the withdrawals can be
made with the absence of penalty once you reach the age of 59 1/2, but
the best time to withdraw from your account is when you reach the age
of 70 1/2. In this case, you will be entitled to almost all of the
retirement benefits without any hassle.
But when is the traditional IRA developed? How it is developed?
According to numerous research studies, the
traditional type of IRA was first created on September 2, 1974 when
President Ford signed the Employment Retirement Income Security Act. It
was considered and introduced to the public to provide a means for
employees who have been deprived of company pensions to save tax
deferred money in an account toward their retirement. Perhaps the best
part of the traditional IRA is that although it was designed to support
the employees without company pensions, it also allows employees who
already have company pensions to contribute to the IRA account.
Eligibility Requirements
For employees certain eligibility requirements
are set for them to meet, to avail the benefits of traditional IRA.
Under the IRA rules, the contributors to the traditional IRA must not
reach the age of 70 1/2 during the year they contribute to the plan.
Also, they must have earned income in order to contribute to the plan.
Contribution Limits
As mentioned earlier, the contributions to the
traditional IRA are tax-deductible. Nevertheless, there are also
particular limits to these contributions. The limits are set based on
the maximum amount allowed for the employees to contribute.
The contribution limit rules hold the following:
- In tax year 2006,
the employees can make their annual contributions to a traditional IRA
of up to $4,000 or 100% of the income they earned from work, whichever
is less. However, it is significant to note that an aggregate of about
$8,000 can be included on the contribution per married couple provided
that either of the couple has earned enough income to support the
contribution for both.
- If
your age is 50 or older, you have the right to consider the so-called
"catch up" contributions to your traditional IRA. But it is vital to
note that over the next several years, the maximum amount set for the
annual contribution will increase without prior notice.
Below is a short summary of the contribution limits considered from the year 2001 to 2010, so please consider the following:
- Tax Year 2001 - $2,000 for those who are under the age of 50. The amount is the same for those who reached 50 or older.
- Tax Year 2002-2004 - About $3,000 is considered for those who are under 50, and $3,500 for age 50 and above.
- Tax Year 2005 - $4,000 for under age 50, and $4,500 for age 50 or older.
- Tax Year 2006-2007 - $4,000 for under age 50 and $5,000 for age 50 or older.
- Tax Year 2008 - About $5,000 is set for under age 50 and $6,000 for age 50 and above.
- Tax
Year 2009-2010 - It has been indexed that about $5,000 will be allowed
for those who are under the age of 50, and about $5,000 indexed plus
$1,000 for those who reached 50 and older.
Note that it is viewed that after 2010, the
traditional IRA limits will return to the levels set for the year 2001.
This is in spite of the belief that future legislation may carry on to
increase the limits.
Restrictions
There are also other restrictions set for the
traditional IRA contributions aside from the necessary maximum amount.
In the first place, it is maintained that in traditional IRAs, no
restrictions occur on how often the contributions can be made to the
plan. However, the deadline for making contributions to the plan for
any taxable year is similar to that of the deadline for filing tax
returns for that given year. For many, this exact deadline would be
April 15.
Withdrawals and Penalties
In terms of withdrawals and penalties, the owners
of the traditional ITA accounts can start making withdrawals free from
any penalty when they reach the age of 59 1/2 years. Withdrawals made
prior to this have certain penalties attached to them. Typically, a 10%
penalty will be incurred along with the federal and state taxes. There
are, however, particular exceptions to this 10% penalty, including
extreme medical expenses, health insurance premiums, first time home
buyers, highly education overheads, death and equal distributions based
on life expectancy.
Roth IRA
The Roth IRA was made as part of the Tax Payer
Relief Act of 1997. It was made effective in 1998 and since then Roth
IRA allows individuals to invest after-tax money and benefit from
qualified distributions that would be free from any charges, be it
taxes or penalties.
Here is some helpful information about Roth IRA:
Eligibility Requirements
You must have earned income to be able to
contribute and benefit from Roth IRA. However, make sure that your
adjusted gross income is within certain limits depending on what is set
on your tax-filing status, for if not, you won't be allowed to
contribute.
Contribution Limits
When it comes to the contribution limit, what is
allowed in the Roth IRA is just the same as to that of the Traditional
IRA. The married couples are allowed to contribute to the plan even if
only one spouse had a job for the year provided that the spouse earns
income that would be sufficient to cover the Roth IRA contributions for
both. Perhaps the only dissimilarity between Roth and traditional IRA
in terms of the contribution limits is the fact that unlike the
traditional IRA, the contributions in Roth can be made after you reach
the age of 70 1/2.
Restrictions
Note that in terms of restrictions, there are
definitely no restrictions set on how often the contributions to the
Roth IRA can be made.
Withdrawals and Penalties
Withdrawals and penalties in Roth IRA are
basically not so common for the reason that certain qualifications are
set for the withdrawals to happen. The distribution must be qualified,
which means that it must be made at least five years following to the
owner's establishment of his or her Roth IRA. Also, the distribution of
this plan must also be made for either of these reasons:
- The owner has turned 59 1/2 prior to the distribution.
- The owner has become disabled prior to the making of the distribution.
- The owner is deceased and the one who receives the assets is the beneficiary.
So that's it. The difference between the
traditional and Roth IRA simply lies on how the contribution is made.
For example, in the traditional IRA, the contributions can be made up
to a particular limit with the contribution tax deductible, while on
Roth IRA, the contributions can be made up to a particular limit on a
non-deductible basis. Also, the limits on withdrawals also differ, and
perhaps what makes the Roth IRA better than the traditional is that it
allows you to contribute to the plan even if you have reached the age
of 70 1/2, which is not true in the traditional IRA.
Now that you've read all the basics of IRA and
its two popular types, have you decided on which to take? Well, weight
your options cautiously. The best method to find the better option is
simply to review all that is involved and not involved in the plans.
Simply understand each one of them, and if you've found the right
option, then don't let it slip away. Start contributing and earn bucks
for better life after retirement.
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